Master Basic Accounting: 100 Essential Questions Answered

The two main branches of accounting are:

• Financial accounting: Provides information to external users, such as investors, creditors, and government agencies.
• Management accounting: Provides information to internal users, such as managers and employees.

• Financial accounting follows specific rules and regulations (GAAP or IFRS) and focuses on providing a fair and accurate representation of the organization's financial position and performance.
• Management accounting is not subject to the same rules and can be tailored to the specific needs of an organization. It provides information to support decision-making and planning.

The purpose of accounting is to:

• • Provide relevant and reliable financial information to users.
  • Facilitate decision-making by providing insights into an organization's financial performance and position.
  • Ensure accountability by tracking and reporting on the use of resources.

The basic accounting principles include:

• • Historical cost principle: Assets are recorded at their original cost.
  • Matching principle: Expenses are recognized in the same period as the revenues they help to earn.
  • Revenue recognition principle: Revenue is recognized when it is earned and the performance obligation has been satisfied.
  • Going concern principle: Assumes that a business will continue to operate for the foreseeable future.
  • Materiality principle: Only significant items should be disclosed in financial statements.
  • Consistency principle: The same accounting methods should be used from period to period.
  • Full disclosure principle: All relevant information should be disclosed in financial statements.

The accounting cycle is a series of steps followed to record and report financial information. It includes:

• • Journalizing transactions
  • Posting to the general ledger
  • Preparing a trial balance
  • Making adjusting entries
  • Preparing an adjusted trial balance
  • Preparing financial statements
  • Closing the books
  • Preparing a post-closing trial balance

Double-entry accounting is a system of recording transactions that ensures that every transaction has an equal and opposite effect on the accounting equation (Assets = Liabilities + Equity). It helps in maintaining accurate financial records and ensuring that the balance sheet balances.

A ledger is a book of accounts that contains all the accounts used by an organization. It is used to record and summarize transactions.

A journal is a book of original entry where all transactions are recorded. It is where transactions are first recorded before being posted to the ledger.

The accounting equation is: Assets = Liabilities + Equity. It represents the fundamental relationship between an organization's resources, obligations, and owners' claims.

The accounting equation works on the principle that every transaction has an equal and opposite effect on the financial position of an organization.

For example, if a company purchases a new asset, it will increase its assets and liabilities (if financed with debt) or equity (if financed with equity).

Assets are resources owned by the organization that are expected to provide future benefits. Examples include cash, inventory, equipment, and buildings.

Liabilities are obligations owed by the organization to other entities. Examples include accounts payable, loans, and taxes payable.

Equity is the residual interest in the assets of the organization after deducting liabilities. It represents the owners' claim on the organization's assets.

The balance sheet shows the organization's financial position at a specific point in time. It lists the organization's assets, liabilities, and equity.

An income statement shows the organization's revenues, expenses, and net income or loss for a specific period. It provides information about the organization's profitability.

A cash flow statement shows the organization's cash inflows and outflows from operating, investing, and financing activities. It provides information about the organization's liquidity and ability to generate cash.

The balance sheet shows the organization's financial position at a specific point in time, while the income statement shows the organization's financial performance over a period of time.

Revenue is the income generated from the sale of goods or services.

Expenses are costs incurred in generating revenue. Examples include salaries, rent, and utilities.

Net income is the difference between total revenue and total expenses. It represents the profit or loss of an organization for a specific period.

Gross profit is the difference between sales revenue and the cost of goods sold. It represents the profit earned before subtracting other operating expenses.

Gross profit is the profit earned before subtracting operating expenses, while net profit is the profit earned after subtracting all expenses.

Accounts receivable are amounts owed to the organization by customers for goods or services sold on credit.

Accounts payable are amounts owed by the organization to suppliers for goods or services purchased on credit.

Depreciation is the process of allocating the cost of long-term tangible assets over their useful lives. It is a non-cash expense that reduces the value of the asset on the balance sheet.

Depreciation is calculated using a depreciation method such as:

• Straight-line method: Allocates the cost of the asset evenly over its useful life.
• Units-of-production method: Allocates the cost of the asset based on its actual usage.
• Declining-balance method: Allocates a larger portion of the cost of the asset in the early years of its useful life.

Accumulated depreciation is the total amount of depreciation expense that has been recognized for a particular asset since its acquisition. It is a contra asset account that reduces the value of the asset on the balance sheet.

Amortization is similar to depreciation but is used for intangible assets, such as patents and copyrights.

Accrual accounting is a method of accounting that recognizes revenues when they are earned and expenses when they are incurred, regardless of when cash is received or paid. This is in contrast to cash basis accounting, which recognizes revenues and expenses only when cash is received or paid.

Cash accounting is a method of accounting that recognizes revenues and expenses only when cash is received or paid. It is simpler than accrual accounting but may not provide an accurate picture of an organization's financial performance.

The matching principle requires that expenses be recognized in the same period as the revenues they help to earn. This ensures that income is accurately reported.

The revenue recognition principle requires that revenue be recognized when it is earned and the performance obligation has been satisfied.

The cost principle requires that assets be recorded at their original cost at the time of acquisition.

• Current assets are assets that are expected to be realized, sold, or consumed within one year. Examples include cash, accounts receivable, and inventory.
• Non-current assets are assets that are expected to be held for more than one year. Examples include property, plant, and equipment.

• Short-term liabilities are obligations that are due within one year. Examples include accounts payable and notes payable.
• Long-term liabilities are obligations that are due after one year. Examples include bonds payable and long-term loans.

Working capital is the difference between current assets and current liabilities. It represents the amount of current assets available to cover current liabilities.

Liquidity refers to a company's ability to meet its short-term obligations. A company with high liquidity has sufficient cash or other assets that can be easily converted to cash to pay its bills.

Solvency refers to a company's ability to meet its long-term obligations. A company with high solvency has a strong financial position and can meet its debt obligations.

A trial balance is a list of all general ledger accounts and their balances at a specific point in time. It is used to verify that the accounting equation (Assets = Liabilities + Equity) is in balance.

Adjusting entries are journal entries made at the end of an accounting period to ensure that revenues and expenses are recorded in the proper period. They are necessary to comply with the accrual basis of accounting.

Closing entries are journal entries made at the end of an accounting period to transfer temporary accounts (revenue, expense, and dividend accounts) to retained earnings. This prepares the accounts for the next accounting period.

A post-closing trial balance is a list of all general ledger accounts and their balances after closing entries have been made. It should show only permanent accounts (assets, liabilities, and equity).

Retained earnings is the accumulated net income of a company that has not been distributed to shareholders as dividends. It represents the portion of profits that the company has reinvested in the business.

Capital refers to the owners' investment in a company. It can be in the form of equity or loans.

A capital expenditure is an expenditure that benefits the organization over a period of more than one year. Examples include purchases of property, plant, and equipment.

An operating expenditure is an expenditure that benefits the organization in the current period. Examples include salaries, rent, and utilities.

A fixed asset is a long-term asset that is used in the operations of a business and is not intended for sale. Examples include property, plant, and equipment.

Inventory is a current asset that represents goods held for sale, in production, or for use in the production process.

FIFO (First-In, First-Out) is a method of inventory valuation that assumes that the first units purchased are the first units sold. This method tends to result in higher net income in times of rising prices.

LIFO (Last-In, First-Out) is a method of inventory valuation that assumes that the last units purchased are the first units sold. This method tends to result in lower net income in times of rising prices.

The weighted average cost method calculates the average cost of all units available for sale and assigns this cost to each unit sold.

COGS is the cost of inventory sold during a period. It is calculated as the beginning inventory plus purchases minus ending inventory.

• Direct costs can be directly traced to a specific product or service. Examples include direct materials and direct labor.
• Indirect costs cannot be directly traced to a specific product or service. They are also known as overhead costs. Examples include rent, utilities, and depreciation.

A chart of accounts is a list of all the accounts used by an organization. It is used to organize and classify transactions.

The general ledger is a book of accounts that contains all the accounts used by an organization. It is used to record and summarize transactions.

A subsidiary ledger is a ledger that contains detailed information about specific types of accounts, such as accounts receivable or accounts payable.

The purpose of an audit is to provide an independent opinion on the fairness and reliability of an organization's financial statements.

Internal control is a system of policies and procedures designed to safeguard assets, prevent fraud, and ensure the accuracy and reliability of financial information.

A trial balance is used to verify that the accounting equation (Assets = Liabilities + Equity) is in balance. It is a list of all general ledger accounts and their balances at a specific point in time.

A bank reconciliation is a process used to reconcile the bank statement balance with the company's cash account balance. It helps to identify any errors or discrepancies.

A petty cash account is a small amount of cash set aside to pay for minor expenses. It is typically used for small purchases that are not worth writing a check for.

he steps in the accounting cycle are:

1. Journalize transactions: Record transactions in the general journal.
2. Post to the general ledger: Transfer journal entries to the general ledger.
3. Prepare a trial balance: Verify that the accounting equation is in balance.
4. Make adjusting entries: Adjust accounts for accruals, deferrals, and depreciation.
5. Prepare an adjusted trial balance: Verify that the accounting equation is in balance after adjusting entries.
6. Prepare financial statements: Prepare the income statement, balance sheet, and cash flow statement.
7. Close the books: Transfer temporary accounts to retained earnings.
8. Prepare a post-closing trial balance: Verify that only permanent accounts have balances.

Bookkeeping is the process of recording financial transactions in a systematic manner. It involves keeping detailed records of all financial activities.

A general journal entry is a recording of a transaction in a journal. It includes the date, account titles, debits, and credits.

• Debit is used to increase asset accounts and expense accounts.
• Credit is used to increase liability, equity, and revenue accounts.

A contra account is an account that has an opposite balance to its related account. For example, accumulated depreciation is a contra asset account that reduces the value of property, plant, and equipment.

Prepaid expenses are assets representing payments made in advance for goods or services that will be received in the future.

Accrued revenue is revenue that has been earned but not yet received.

Deferred revenue is a liability that represents revenue that has been received in advance but has not yet been earned.

A contingent liability is a potential liability that depends on the occurrence of future events. It is disclosed in the financial statements if it is probable and can be reasonably estimated.

• Capital expenditures are expenditures that benefit the organization over a period of more than one year. Examples include purchases of property, plant, and equipment.
• Revenue expenditures are expenditures that benefit the organization in the current period. Examples include salaries, rent, and utilities.

A provision is a liability that represents a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources.

Financial statements are formal documents that provide information about an organization's financial performance and position. They typically include the income statement, balance sheet, and cash flow statement.

A statement of changes in equity shows the changes in the equity section of the balance sheet over a specific period. It includes the beginning balance, net income, dividends, and other equity transactions.

The going concern assumption assumes that a business will continue to operate for the foreseeable future.

The time period assumption states that financial information should be presented for specific periods of time, such as monthly, quarterly, or annually.

Materiality refers to the significance of an item of information. Only items that are significant enough to affect a user's decision should be disclosed in financial statements.

A fiscal year is a 12-month period used for accounting purposes. It can be any 12 consecutive months, while a calendar year is always January 1 to December 31.

Dividends are payments made to shareholders out of the company's profits.

• Common stock gives shareholders voting rights and the right to residual claims on the company's assets.
• Preferred stock gives shareholders priority in receiving dividends and may have other special rights, but typically does not have voting rights.

Treasury stock is a company's own stock that it has repurchased from shareholders.

• Capital stock is the total amount of stock issued by a company.
• Paid-in capital is the amount of money received by a company from the sale of its stock.

EPS is a measure of profitability that calculates the earnings attributable to each common share. It is calculated as (Net income - Preferred dividends) / Weighted average number of common shares outstanding.

The statement of cash flows shows the organization's cash inflows and outflows from operating, investing, and financing activities. It helps in understanding the organization's liquidity and ability to generate cash.

Horizontal analysis compares financial data from different periods to identify trends and changes. It is often presented as a percentage increase or decrease.

Vertical analysis expresses each item on a financial statement as a percentage of a base amount, such as total assets for the balance sheet or total revenue for the income statement.

A financial ratio is a calculation that analyzes a company's financial performance and position. It can be used to assess profitability, liquidity, solvency, and efficiency.

The quick ratio is calculated as: (Current assets - Inventory) / Current liabilities. It is a more stringent measure of liquidity than the current ratio because it excludes inventory, which can be less liquid.

ROA is a measure of profitability that calculates the return on the total assets of a company. It is calculated as (Net income / Total assets) x 100%.

ROE is a measure of profitability that calculates the return on the equity invested in a company. It is calculated as (Net income / Average shareholder's equity) x 100%.

The debt-to-equity ratio is calculated as: Total liabilities / Total equity. It measures a company's financial leverage and its ability to meet its long-term debt obligations.

A budget is a financial plan that forecasts an organization's expected income and expenses for a future period.

The purpose of a budget is to:

• Plan for future operations and resource allocation.
• Control costs and expenses.
• Evaluate performance against goals.
• Improve decision-making.

A variance is the difference between actual results and budgeted amounts. It can be used to identify areas where performance is deviating from expectations and to take corrective actions.

• A favorable variance occurs when actual results are better than budgeted results.
• An unfavorable variance occurs when actual results are worse than budgeted results.

The purpose of financial reporting is to provide relevant, reliable, and comparable financial information to external users, such as investors, creditors, and government agencies.